2005-09-03

How are these connected? Ans: through the concept of "metastability" and "equilibrium point". Look at the diagram to the right,

The ball in the diagram on the left is in a stable state. Whichever side you push the ball, it is going to go back to the point as shown, its equilibirum state

The ball in the middle is at a meta-stable state. Move it a little, it roll to one of the sides

The ball in the right is in neutral equilibirum. Move it and it stays wherever it is put at.

Now to Katrina. The water in the Mississippi around New Orleans is above sea-level (that is why it would continue to flow into the sea) and 80% of the city of New Orleans is below sea-level, and therefore, further below the Mississippi water level. NO is in a metastable position and Katrina is the finger that moved the ball. That is why the flood never recede in New Orleans. The water in Mississippi is like the ball in the middle figure of the 1st diagram. Look also at the 2nd diagram (source LSU, click for details) to the right where the yellow areas are portion of the city below sea level, and green areas above sea level but below river level. The 3rd diagram here is a cross-section diagram showing how dangerous the situation has always been. We are familiar with the legend of Hans Brinker who plugged his thumb into the dike to save Holland but not many (including myself) knew that New Orleans is a Holland in the US.

The Yellow River (Huang He) in China, through thousands of years of flooding and dam-reinforcing, has its riverbed a few meters above the cities around it. In 1931 the flood killed millions of people. But water eventually receded because the ground is still above sea-level and there is somewhere for it to flow to.

New Orlean is different. The only solution is to reinforce the dikes, then pump out all the water. In future, we still need our hero Hans Brinker on guard. Even more so if one believes in the theory of global warming and polar ice melting. Because sea level can only be rising in such scenarios.

Now what does this have to do with speculators and oil price? In my previous post, I suspected the current oil price has surpassed what demand and supply should dictate. If that is the case, $70 would represent a metastable price (1st diagram, middle figure) while the left figure is probably somewhere between $70/barrel and the $20-30 price a few years ago. No one really knows where the equilibrium point (right figure) is, and in reality price never really settles at the equibrium, as trading activities will move it around and the equilibrium itself shifts as demand and supply change every second. When speculators are moving in a direction following the "natural law" toward the equilibrium, no one can really stop them. (e.g. Asian Financial Crisis, Oil price from 2000-2004). But once they sail beyond where equilibrium is, it is like New Orleans' altitude situation. You can defend it in short term. Sooner or later it is going to move back toward its point of equilibriums. Like the release of a pendulum, it always overshoots. Speculators want to maximize their profit and will always push to the other extreme. But sooner or later it will move back. (See RMB in 1998 vs today). The Hans Brinkers of the world are admirable, but like the Asian central bankers in 1997, their effort will be futile (螳臂挡车). Same for speculators who ignore the fundamentals.

This applies to the RMB exchange rate regime as well. Before July 21, RMB was tied to USD, and at some point has been driven way passed the equilibrium point. One can argue RMB is still undervalued today, but at least it is not going to drift away further with the new mechanism in place. The objective should be to bring it closer to where it belong, slowly. The huge dike of capital control should insulate the flood, but its job would be easier if the differentials in water level is not too drastic.

2 comments:

NYT has an article on oil supply, where one key point has been raised. higher price leads to the availability of reserves too expensive to be extracted at low oil price, hence the additional supply will correct oil price automatically.